Monday, October 10, 2011

The Brain's Permanent Income Hypothesis

The Keynesian consumption function assumes consumption is entirely based on current income, and is the basis for the multiplier, which magically translates investment in alien defense systems into greater prosperity. Milton Friedman's permanent income hypothesis is a theory of consumption whereby consumption is determined not by current income but by one's longer-term income expectations. The key conclusion of this theory is that transitory, short-term changes in income have little effect on consumer spending behavior. Federal stimulus plans, for example, are intrinsically temporary.

It seems are brains are intrinsically forward looking, more focused on anticipation of rewards than the rewards themselves. In studies with monkeys, where the monkey sees the light, pushes the button, and gets a treat, very quickly the monkey figures it out. Interestingly, the dopamine response fires not when he eats or receives the treat, but rather when he sees the light. The brain present values the stimulus, so that by the time the treat is tasted it has already been figuratively consumed. A short video on the dopamine effect is here.

It's a lot harder for the government to redistribute wealth than income, because wealth is primarily ability as opposed to cash. If you have a niche, a role where you feel valued, you are wealthy. The government can create only so many post-office jobs that grant sinecures arbitrarily, and all those temporary job incentives are seen as the transitory, ephemeral things that they are. To create real wealth, which is what really matters, you need to allow individuals to find their niches, which is best done indirectly.

7 comments:

I agree with the ideas in your post, and would like to raise another possibility.

Rephrasing what you said, in order to reduce the pain of unemployment, spending money does not help. Creating fake jobs does not help either. If you can create fake jobs which feel like real jobs - that would work.

I propose this has already been going on for 20 years. A substantial proportion of the jobs are fake jobs which make people feel-good. It is exactly this solution which has been squeezed to the end, and the current crisis signals this.

I'm not optimistic on the future of the welfare state, I think it will only tend to grow globally as capitalism + technology leverages the abilities of the most productive people, so that 1 person can serve millions and thus create a log-scale distribution of wealth, which is incompatible with primitive envious urges!

And when nano-tech enables the rich to "buy" hundreds of years of additional lifespan, the poor will revolt and demand that it be rationed somehow other then cash, just as today you HAVE to have open heart surgery on medicare even if it costs many times your life's income. So the more tech advances the more the welfare state will demand!

Some people are already thinking about the need to create "jobs" for (*ahem*) certain people that feel useful and productive but are really production-free, wheel-spinning games - http://takimag.com/article/the_dignity_of_sloth#axzz1aOGUViYG

The conclusion that government spending is totally useless depends on the assumption that government can never outsmart the the free market, which must be true 90-99% of the time, but where there are useful projects we can embark on the government would do well to subsidize industries which will end up employing *real* people who may actually do some useful stuff. Especially when those industries would be natrual monopolies or have public goods issues anyway. I'd generally put infrastructure in this category, but you could add military research, or if you wanna get crazy solar energy or something like that. Just a thought.